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Microsoft's Aggressive New Pricing Strategy

Microsoft has long enjoyed Olympian profit margins, using its monopoly power to maintain prices on its software even in tough times. But now, amid a terrible downturn and rising competition, CEO Steven A. Ballmer is shifting to a scrappier approach. He is cutting prices on a variety of fronts, from flagship Windows and Office products to newfangled Internet services.

The idea is to accept lower margins in some businesses but boost overall earnings by going after a grab bag of growth opportunities. These range from expanding its share of big companies' software purchases to lowering the price of Office software so consumers in emerging markets pay for it rather than pirate it. With the outlook so cloudy, "we're focusing on gaining share in those areas that are most critical," says Stephen A. Elop, who heads the business division.

On July 13, Elop demonstrated the new Office 2010 in New Orleans. While Microsoft expects most customers to pay for the program the way they always have, less powerful, ad-supported versions will be available free on the Web. The company is also charging a monthly fee for online applications, such as the e-mail program Exchange, which is about a third as profitable as selling the software on CDs. And on Oct. 22, Microsoft's new Windows 7 PC operating system will go on sale in stores for $40 less than the $240 it charged when it launched its Vista program in 2007—the biggest price cut on a new version of Windows in years.

All of these moves amount to a risky experiment in price elasticity. By lowering prices, the company hopes to increase sales of existing products while making fast headway with new ones. If the company can gain enough market share to cover its massive costs in Web services and Internet search—notably, its vast data centers—every extra dollar will be pure profit. "I'm not saying it will be easy," says Ballmer. "But we have great opportunities to grow total profit dollars."

ONLY $29 IN CHINA

Microsoft is cutting the price of Office and offering the free versions of Word, Excel, and other programs to head off competition from Google and other rivals that offer similar software at little or no cost. Microsoft has so many promotions for Office that its effective price is $100, down from $150, and even lower in such countries as Brazil and India. But the experience is sparking optimism at Microsoft about the new strategy. The company says unit sales of Office surged 415% in the second half of last year.

The most aggressive price cut has come in China, where Microsoft says 95% of Office installations have been pirated. Since it began testing a $29 offer in China last September, sales have soared more than 800%. The low price was "like taking firewood from under the cauldron" of piracy, says Liu Tianxiang, a vice-president with Beijing Federal Software, a Chinese software distributor. He figures Microsoft has sold 80,000 copies of Office in China since the trial started. Now Microsoft intends to make the low price permanent.

Not surprisingly, Microsoft continues to hunt for ways to offset price cuts. It hopes to boost the bottom line by encouraging Windows 7 software users to upgrade more often. Since the program CD will come loaded with multiple versions, users who buy the cheaper Starter edition can easily pay later to get premium features. Of course, that risks annoying users—when rivals such as Google are trying to lure customers with cheaper alternatives. But in the current economy, there's no risk-free way to stay ahead.